The Magnificent Seven Rides Again
MODERNIST’S ASSET CLASS INVESTING PORTFOLIOS ARE STRATEGICALLY INVESTED WITH A FOCUS ON LONG-TERM PERFORMANCE OBJECTIVES. PORTFOLIO ALLOCATIONS AND INVESTMENTS ARE NOT ADJUSTED IN RESPONSE TO MARKET NEWS OR ECONOMIC EVENTS; HOWEVER, OUR INVESTMENT COMMITTEE EVALUATES AND REPORTS ON MARKET AND ECONOMIC CONDITIONS TO PROVIDE OUR INVESTORS WITH PERSPECTIVE AND TO PUT PORTFOLIO PERFORMANCE IN PROPER CONTEXT.
The “Magnificent Seven” stocks had another terrific year in 2024 with a year-to-date return of 53.7% (!) through November 30, 2024. Meanwhile, the S&P 500 index was up 28.1%. Nvidia alone contributed 5.5% of the S&P 500 index return. A single stock accounted for nearly 20% of the market’s gain! As a group, the seven stocks contributed 12.1% of the return. (1)
The surge in these stocks has many investors asking: “Am I missing out?”
While having some exposure to these stocks can benefit investors, an evidence-driven investing strategy would not recommend putting all your eggs in this basket. History suggests reasons why:
Chasing the strong returns of the largest stocks has not been a winning strategy.
The fund manager Dimensional conducted an analysis (2) of stock returns of companies before and after they became one of the 10 largest in the U.S. stock market. The research team calculated the average five-year returns in excess of the market before and after joining the top 10. The returns prior to joining the top 10 were excellent, outperforming the market by 20%. However, the returns in the five years after joining the top 10 were lackluster, underperforming the market by -0.9%. While not terrible, the average outcome suggests that the strong returns realized in stocks that become the largest are not likely to persist in the following period.
Shunning small stocks in favor of very large stocks may also lead to missing out.
In a recent Eye on The Market report (3) from J.P. Morgan, the authors reviewed the historical performance and characteristics of small company stocks. The authors observed that “From 1930-2010, there were six extended periods of small cap outperformance as it dominated large cap over that entire period.”
Additionally, they found that small stocks are trading at about a 25% lower price relative to their earnings than large stocks. A similar valuation discount was observed during the “Tech Bubble” around the year 2000. Small stocks subsequently outperformed large stocks over the next several years after that period.
The evidence suggests investors are better off owning a broadly diversified portfolio that includes both large and small stocks. This increases diversification and avoids over-concentrating risk in one area of the market.
Diversification is always working for you, but sometimes the result is underperformance to hot stocks or popular indexes. The fear of missing out (FOMO) on spectacular returns is natural for most investors. However, staying focused on your portfolio performance relative to your personal goals can help you avoid jumping into an investment at just the wrong time.
